‘Sloppy’ tech stock research a disturbing reminder of ’99

It’s not the euphoria of the investment community that has fired up Sahm Adrangi of Kerrisdale Capital, seen here in midtown Manhattan, rather it’s the incompetence of the sell-side analysts that cover this space.
Photo: Jennifer Altman

He’s boosted the size of his fund to $200 million from $1 million in just three years, initially from identifying fraudulent Chinese listings but has more recently focused in mid-cap technology stocks.

Kerrisdale has gone to town on the work of analysts covering a stock called ServiceNow, an IT enterprise software firm that specialises in cloud computing. The company’s stock traded on the Nasdaq under the ticker NOW and has a market capitalisation of about $US8 billion ($9 billion). The share has gained 118 per cent in the past 12 months, compared with the 33 per cent rise of the Nasdaq Composite index.

Related Quotes

Company Profile

Underestimating the outstanding

He points out that they have failed to calculate the correct amount of outstanding shares in the company by overlooking lucrative employee options, which would add about 30 million issued shares. This capital, if properly accounted for, would only raise an additional $200 million of capital but would burden the register with $1.75 billion of stock – diluting the worth of existing shares.

“In the case of young companies, particularly in technology, analysts can’t overlook stock option grants to employees. Since tech start-ups tend to be short on cash and long on blue sky potential, they forgo paying higher compensation in the short-run and defer it via options," he said.

“Usually this doesn’t make too much of a difference in the long run, but if a company is particularly successful, and/or its shares perform exceedingly well, the impact of options grants given to executives and early-hire employees can be dramatic"

Adrangi singles out analysts from Wells Fargo, Barclays, Credit Suisse, Deutsche Bank, Susquehanna and Stephens who have all made errors in underestimating the number of outstanding shares.

“In reality there are 169 million shares of ServiceNow, or 165.4 million using the treasury stock method, rather than the 139 million you see reported at sites such as Yahoo or Google.

“And it’s excusable that these free finance sites are wrong; you get what you pay for. This is why an investor should always check a company’s filings rather than simply trusting a free website’s computer-generated financial information"

“It’s less excusable when professional equity research analysts, trained at top business schools and working at prestigious investment banks, are no more reliable than Google Finance"

Sell-side analysts are considered one of the main culprits of the tech boom, as they got the blinkers and the pom-poms out to promote stocks – egged on by the large investment banking fees from capital raisings and IPOS.

‘Most-prodigious creator’

Adrangi recounts plenty of examples from the late 90s, that for some have faded from memory.

There’s Salomon Brothers Jack Grubman upgrading AT&T to get his kids into an exclusive nursery school, WorldCom CEO Bernie Ebbers refusing to give Merrill Lynch business until it upgraded the stock and Henry Blodget, who now runs the Business Insider website, describing a stock as “a piece of shit".

Adrangi says the same root cause for sloppy analysis is behind the upbeat outlook for ServiceNow.

“Despite all the talk of a wall between investment research and banking fees, it’s clear where Wall Street’s bread is buttered. Which brings us back to ServiceNow, as NOW has been a most-prodigious creator of banking fees itself. A cynical person might suspect that ServiceNow’s propensity to unceasingly emit new stock and debt, and in the process offer lucrative fees to investment bankers, is in some way tempting analysts to look for the bright side of ServiceNow’s rather cloudy forward business prospects"

Adrangi is short the stock.

“ServiceNow insiders have been dumping shares, issuing dilutive financings, and waiving lock-up commitments for IPO shares in order to, it seems, squeeze as much cash as possible out of its overinflated share price